Endowment resilient in face of downturn

Around the country yesterday, university financial wizards like Chief Investment Officer David Swensen got good news and bad news.

Early in the day, they received word that, according to an influential benchmark, university endowments last year posted their largest gains in recent memory. Then came something less encouraging: By the end of the day, the Dow Jones Industrial Average had plunged 300 points, continuing an economic free-fall that shows little sign of letting up.

That decline in the markets, economists say, means that last year’s soaring endowment returns are likely a thing of the past. But Yale may be able to weather the storm better than most schools as a result of its highly diversified portfolio of endowment assets, according to financial experts interviewed by the News.

In the fiscal year that ended June 30, the average annual return earned by American university endowments jumped to 16.9 percent, up from 10.6 percent the year before, according to a study released on Thursday by the non-profit Commonfund Institute in Wilton, Conn.

Yale’s endowment soared a nation-leading 28 percent, to $22.5 billion, in that period, marking the fourth straight double-digit return and an increase so large that it helped push the University to decide to increase the amount of money it spends from its endowment.

But those types of returns are not likely to be seen again this coming year, experts said. So far, just over six months into the 2008 fiscal year, the S&P 500 index has fallen more than 11 percent, an inauspicious sign for university investments.

Richard Anderson, an endowment consultant for Hammond Associates in St. Louis, said he would not be surprised to see some college endowments — especially those that are invested heavily in equities — decrease in value over the course of this fiscal year.

“It won’t be as easy for anyone, including David, going forward,” Anderson said, referring to Swensen, the University’s highest-paid employee and an almost God-like figure in the world of institutional investing. “[Returns] are going to change very drastically.”

Still, Anderson added, “I’m not predicting that for Yale.”

The reason, he and other experts said, is the extent to which Yale’s endowment is diversified, particularly in alternative investments like venture capital, hedge funds, timber, oil and gas. Almost 70 percent of Yale’s fund is invested in those types of assets, according to the University’s 2007 Endowment Report.

Even with a manager like Swensen and its diversified portfolio, Yale will still be affected by the economic downturn, said William Jarvis ’77, managing director at Commonfund. But universities with smaller endowments — which tend to be invested much more heavily in equities and bonds, with little use of alternative strategies — will be much more vulnerable to the souring market, he said.

It is times like these when Yale’s emphasis on diversification is vindicated, Jarvis and other experts said. Roger Kaufman, an economist at Smith College, said the University’s large investment in alternative assets — providing those assets have been chosen wisely — should help soften the blow of any losses due to the stock market’s decline.

“The schools that have diversified outside of stocks and bonds, their portfolio is not as linked to the stock market as others,” Kaufman said. “If they have created their portfolio appropriately, then their diversification should reduce the decline in their assets.”

This year would not mark the first time Yale’s endowment performance has surpassed other schools’. In 2001, for instance, the University’s endowment gained over 9 percent, even while the endowments of most American universities, Harvard among them, lost money.

And, as it did then, Yale will again weather the financial storm, administrators said Thursday.

“Everything can’t be good all the time,” Deputy Provost Charles Long said. “I don’t think anybody believes that any of the principles by which we invest our money — namely, by diversifying and looking for a wide variety of different kinds of investments — isn’t the right way to handle, it whether the markets are going up or the markets are going down.”

Still, experts stressed that alternative investments, despite the extent to which they have been in vogue since the late 1990s, are not guaranteed money-makers. And Commonfund found that over the last year, the rate at which universities shifted their assets into such investments has slowed nearly to a halt: endowments worth over $1 billion allocated 47 percent of their assets to alternative investments last year, only 1 percentage point higher than in 2006.

That much was expected, experts said. As an asset class outperforms others, investors flock to it, and good investment opportunities diminish, said David DeRosa, an adjunct professor of finance at the Yale School of Management and the founder of the New Canaan, Conn., consulting firm DeRosa Research and Trading.

But, at Yale, even that might not matter much, he said.

“We have choices that most institutional and private investors may not have,” DeRosa said. “Where you’ve got some really professional people like we do, with our reputations and records, we are the kinds of clients that hedge-fund managers want.”

And it is for that reason, at least in part, that University administrators seem mostly unconcerned about tapping further into Yale’s endowment riches to pay for operating costs just as Wall Street begins to panic.

In an interview on Thursday, Levin — who holds the Frederick William Beinecke professorship in economics — said the University’s wide range of investments should help protect against the decline in the equities markets, although some of Yale’s alternative holdings — like those in real estate, for instance — are in as dire straits as is the stock market.

But Levin said that on balance, the University and the Yale Corporation concluded that the stock-market fears were not dire enough to preclude Yale from boosting its endowment spending. On Jan. 7, Yale announced it would increase spending from its endowment next year by nearly 40 percent, from $843 million to over $1.1 billion, as a result of a change to the University’s formula for determining how much of its wealth it should spend annually.

With the additional revenue, Yale will help fund the possible expansion of the undergraduate student body, the launch of new research on the West Campus and greatly increased financial aid. In recent months, Congressional leaders had criticized wealthy institutions like Yale for raising tuition even while their endowments soared. Senator Chuck Grassley, the ranking member of the Senate Finance Committee, suggested universities should be forced to spend at least 5 percent of their endowments annually.

Yale’s endowment payout is determined primarily based on the University’s payout from the previous year, adjusted for inflation, and the current market value of the endowment has significantly less influence in determining the payout. Yale aims to spend 5.25 percent of its endowment annually, but this “smoothing rule” has often meant that Yale has spent significantly less than that in the immediately preceding years.

Indeed, this year Yale will spend only 3.7 percent of its endowment. But from now on, the University will spend between 4.5 percent and 6 percent, an aggressive step for an institution that has long managed its budget conservatively and with an admitted emphasis on long-term financial stability.

That stability will still be ensured with the new spending policy, Provost Andrew Hamilton said Thursday, because the smoothing rule has not been altered — even if the market takes a turn for the worse.

“This ensures that fluctuations in the market value of the endowment … will be smoothed over multiple years and in doing so reduce the volatility in the flow of endowment income to the operating budget of the university,” Hamilton wrote in an e-mail.

At the same time, it will also bring Yale more in line with its peers in terms of endowment spending. Last year, when Yale spent 3.8 percent of its endowment, the average American university spent 4.5 percent, according to Commonfund.

Regardless, Yale officials remain unflappable.

“You just have faith that the investment folks are anticipating where the best investment opportunities are,” Long said, “and adjust their funds accordingly.”

And Swensen, bull market or bear, has proven he knows something about that. But that’s not to say Yale is expecting the money to keep pouring in without restraint.

“We’re certainly not counting on another year like the last four,” Levin said.